Learn everything about debt mutual fund

You will know what is debt mutual fund in next 10 minutes

One fine morning, I was sitting in the office of one chartered accountant in surat. It was an introductory meeting.

I didn’t go there to file my ITR or regarding GST, as typically happens whenever we visit CA. But that day Agenda of the meeting was different. 

Because, along with CA, he was a registered mutual fund distributor. 

So, I visited him to talk about our mutual fund products. 

As happened in every call, I started presenting our equity products.

But, He cut me short. Yashpal, I only sell debt products, show me your debt products and their returns only.

He added, I do not want daily headaches from retail customers whenever the equity market goes up and down.

So, I just focus on a select group of corporate clients who invest in debt products. I just educate them about what is debt mutual fund. And benefits of it to park money for short to medium term.

Debt products give me low brokerage ,but I am happy with that because of its steady returns.I do not get daily complaints in it, and I can focus on my main work which is tax practice.

Well, before visiting him, I did my homework. His 90% of AUM was from debt products and just 10% from equity. Still I tried to pitch him our equity products but he had a clearer goal of what he was doing.

So, without wasting more time I went straight to the debt products.

From the whole incident, I guess you might have noticed some features of debt mutual funds.

That is steady returns like Fixed deposits. No volatility like equity mutual funds.

Is this really a feature of a debt mutual fund ? Or just a perception built around it?

In the case of debt mutual funds too, I have seen a high level of mis-selling. 

Debt mutual funds are sold as a replacement to Fixed deposits, RD and bank savings, with superior returns and same level of safety of capital.

It may be partially true, but without proper knowledge of how a debt fund works and various types of it, it may become harmful to your money.

So, I thought of writing a complete article on what is debt mutual fund and is it really for you or not.

Here we will try to understand what is debt fund with an example.

I am sure after reading this article you will be able to decide on your own whether a debt mutual fund is suitable for you or not.

You will even be able to pick debt mutual fund products on your own.

So, first of all

What is debt mutual fund ?

Learn everything about debt mutual fund
Debt mutual fund

If you do not know anything about mutual funds, first you should learn about mutual funds.

If you are aware about mutual funds, then you surely know it is a big pool of money collected from various investors and invested in different asset classes like equity, debt and gold etc.

So, Unlike in equity mutual fund where money is invested in stock market. In debt mutual funds money is invested in a wide range of debt instruments

What is debt in mutual fund ?

We will try to understand it in very easy language.

As you might be aware that for running a business, money is required. For running government money required as well.

Businesses and governments get revenue and profit that run their business. But, what if some additional money is required by them for a short term ?

Or say, What if the government is looking for infrastructure development which requires very long term investment?

One way of raising this kind of money is from the stock market.

Another way is, they issue bonds and promise to pay you fixed interest. This is called a debt instrument.

If a corporation or government wishes to raise money for a short time like 15 days or 30 days, they issue papers of that said period and interest for the same.

The market where money is raised for the short term is called money market. It is governed by the RBI in india.

And if the government is looking forward to raising money for long term projects like infrastructure, they issue government securities, popularly known as G-sec.

G-secs are comparatively long term debt instruments, like 10 years duration papers, unlike money markets where short term papers are issued having duration less than 1 year.

I hope you are clear now, where your money is invested in debt mutual funds.

As you are now aware that where your money is invested, we will see different types of debt funds as per their time duration of investment.

Types of debt mutual fund

There are various categories of debt mutual funds as per their time duration of papers.

1. Overnight fund 

In this type of fund money is invested in commercial papers with high credit ratings.

Maturity of these papers is overnight, say one day.

This is why it is the safest form of debt instrument. 

But as it matures in just one day , its returns are lowest among all kinds of debt instruments.

Overnight mutual funds invest in this type of papers , making it safest form of fund with lowest returns parallel to bank savings

2. Liquid fund

In this type of debt fund money is invested in CBLO or in commercial papers with maturity of 14 days up to 1 month 

Same as overnight funds, this fund is considered as the safest investment because of it’s short maturity duration. 

It provides low returns because of small maturity time.

Short term debt fund

Also called money market fund, in this type of fund , money is invested in papers having maturity of 3 to 6 months 

It provides better returns than liquid funds.

It should be considered for investment if the money holding period is up to 1 year.

Medium and long term debt funds

In medium term funds money is invested in corporate bonds or in govt bonds having maturity up to 3 years 

While in the long term money is mostly invested in G-Sec.

As time durations are long for investment better interest is given and it comes with greater risk of interest rates changes.

Value of these funds fluctuates with RBI interest rates policy changes. 

Because the maturity period of these funds is longer it may happen to see more policy changes than short duration funds.

So , your money should be invested keeping these things in mind.

5. Credit risk funds

These are type of medium term debt funds having more credit risk.

As the name suggests, these funds bear credit risk.

Money is invested in corporate bonds of companies having lower credit ratings.

As companies have lower credit ratings , they are charged more interest compared to high credit rating companies.

These funds provide better returns due to higher interest income out of this.

But they bear more risk of credit default because of the low credit rating of the companies invested. 

So, if you are conservative investor , you should avoid these types of debt mutual funds.

Now we will see major comparison,

Equity mutual fund vs debt mutual fund 

Simple to guess now from the names , equity mutual funds are funds where money is invested in equity. Debt mutual  funds are those where money is invested in the debt market.

Now, We will go a bit deeper on this topic.

We will discuss its fundamentals and safety of the funds.

As we know now, in equity mutual funds money is invested in the stock market by mutual funds on behalf of you. So, basically you are a shareholder in any particular company.

Equity mutual fund vs debt mutual fund

Shareholders are basically partners in the company. So, in case if a company happens to close and liquidate, shareholders are given last priority, only after debtors and special shareholders.

So, First debtors’ debt gets cleared out of assets of the company then special shareholders and then if something is left it is distributed among retail shareholders.

So, the rights of debtors or creditors are much more than shareholders of the company in case of liquidation of the company.

And the reason for it is simple: creditors provide money to the company and earn interests while shareholders invest money in the company and share profit.

So, if you are a conservative investor looking for interest income and capital safety, you should go for a debt mutual fund.

And if you are an aggressive investor looking for high returns with calculated risk, you should go for an equity mutual fund.

Now, we will see another major comparison which is confusing many.

Fixed deposit vs debt mutual fund

What is better Fixed deposits or debt mutual fund

In this comparison, we will not limit our comparison to just fixed deposits, we will see each and every conservative investment options like bank savings, recurring deposits and EPFO.

We will compare it with various types of debt mutual funds.

1. Fixed deposits and EPFO

For your information, Banks are bound to invest some part of your Fixed deposit money in government securities. 

They earn interest from it and share that income with you in the form of FD interest.

It can be compared with medium to long-term debt mutual funds. So you can compare both returns and choose accordingly.

EPFO is a very long-term investment instrument, so they invest purely in G-Sec and provide you return in line with RBI interest rates policy.

2. Bank savings 

Here banks invest your savings in the money market which provides you liquidity as well as some returns.

You can compare returns of bank savings with liquid and overnight mutual funds returns.

But, one thing to remember,  in liquid mutual funds, it will take up to 2 working days to get money in your bank account,  while in a bank savings account you have immediate liquidity. 

3. Recurring deposits 

You can compare it with short-term debt funds with maturity up to 1 years papers.

I hope by comparing this you can have a proper idea about interest rates of debt mutual funds.

Tax on Debt mutual fund

Become tax efficient by learning tax on debt mutual fund

Income from capital appreciation from Debt mutual funds is taxed in 2 forms.

1. Short-term capital gain 

Definition of short term in debt mutual fund is 36 months or 3 years. So, If you are withdrawing money within 3 years and having capital gain, it will be taxed as per your regular income tax slab.

2. Long-term capital gain 

If You are withdrawing money after 3 years,  then an LTCG of 23.296% will be levied.

But the good thing is, that taxable income will have indexation benefits.

I will write a separate article on indexation.

Apart from that, I hear one most frequent query about any tax on dividends from debt mutual funds

Any dividend from a debt mutual fund attracts dividend distribution tax (DDT), which is 28.84% including surcharges for individuals.

Best debt mutual fund houses in India

Well, there are almost 50 fund houses in India.

But, you should go with old fund houses to invest in debt funds.

Because old fund houses have a long history of investing in debt funds.

Because of their long history, they got better expertise in managing debt funds than new funds.

One more reason to choose an old fund house is their higher amount of investment and the experience of their dedicated fund managers to provide better stability in returns.

In my opinion, you should study the returns of various debt funds of Franklin India MF, HDFC MF, SBI MF, Nippon MF, and ICICI MF.

If you are looking for a liquid fund, personally my experience was great with Nippon liquid fund.


Debt funds are good for you if you are looking for regular fixed income with capital safety. Debt funds will not build wealth for you like equity funds but due to regular interest income, they will provide you with fixed returns. In debt funds also you may see capital loss due to interest rate fluctuation, which is more likely in long-term debt products. So, choose your product wisely as per your requirement and investment horizon.

So, that’s it about debt mutual funds. What do you think about it? Please let me know in the comment or feel free to connect with me.

Frequently Asked Questions

Is it a good time to invest in a debt fund ?

As applies to all mutual fund schemes, there is no good or bad time to invest in debt funds. You can start investing in it at any point of time. You just need to remember whether the product you are choosing is right or wrong for you.
Not time but choosing the product opposite to your need will definitely affect your capital.  If you are looking forward to parking money for saving purposes for one month and investing in any long term debt product seeing higher returns then it is definitely the wrong move.
Because just one interest rate change and you may witness fluctuation in the long term debt fund. So, a better option is to go for a liquid fund for the short term.

What is the risk in debt funds ?

Major risk in any debt fund is interest rates risk. Price debt funds fluctuate as per the interest rates policy of RBI. Short term duration funds having maturity of less than 3 months are less likely to be affected by that risk than long term debt funds like G-sec.

What is better FD or Debt mutual funds ?

Returns offered by both instruments are similar because the asset class in which both are investing is the same. Debt funds may see little superior returns due to active fund management. Another benefit or Debt mutual fund over FD is in taxation.
While income earned from interests of FD is added in your taxable income annually and taxed as per your income bracket. In a debt fund , you are taxed as per your holding period and capital gain. Also, in long term capital gain you get the benefit of indexation. So, you can get better tax efficiency with debt mutual funds.

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